Food scare driving away Yum, McDonald's diners in China

(Reuters) - A food safety scare in China is testing local consumers’ loyalty to foreign fast-food brands, including McDonald’s Corp and Yum Brands Inc, which owns the KFC and Pizza Hut chains.

A burger set is displayed at a McDonald's restaurant in Hong Kong in this photo illustration taken July 31, 2014. REUTERS/Bobby Yip

Yum said on Wednesday that the scare, triggered by a TV report earlier this month showing improper meat handling by a supplier, Shanghai Husi Food, caused “significant, negative” damage to sales at KFC and Pizza Hut restaurants over the past 10 days. “If the significant sales impact is sustained, it will have a material effect on full-year earnings per share,” Yum said in a regulatory filing.

At least three brokerages cut their profit estimates for Yum for 2014 and 2015.

RBC analysts said Yum’s China sales could be hurt 10-15 percent for 6-8 weeks, and cut their price target to $85 from $94.

UBS analysts said the initial consumer response was worse than feared, and the company should reinstate reporting monthly figures to reduce uncertainty. Officials from McDonald’s in China and Hong Kong have not responded to requests for information on the impact on sales from the scandal, but McDonald’s Holdings Co (Japan) Ltd on Tuesday scrapped its full-year earnings guidance after the China scare forced it to switch to alternative chicken supplies.

A McDonald’s Japan executive said sales had dropped 15-20 percent on a daily basis due to the scare. Both McDonald’s and Yum are looking to China - where consumers see foreign brands as offering better food quality - for long-term growth given the size of its population, growing middle class and rapid economic growth. “Both of these stocks are banking heavily on China for their future growth,” said Richard Brubaker, an adjunct professor at the China Europe International Business School and founder of the Collective Responsibility consultancy.

“For Yum, this is a problem because it has a history of problems in China. For McDonald‘s, it’s the sheer size of the problem and the inability to get product.”

CONSUMER CAUTION Yum, which has nearly 6,400 restaurants in China, had just begun to see its restaurant sales there recovering from a slide last year due to an avian food outbreak and a previous food safety scare. Yum has cut its global ties with OSI Group LLC [OSIGP.UL], the U.S. parent of Shanghai Husi Food. Yum said OSI was not a major supplier and the move had “minimal disruption” to the availability of menu offerings in China. McDonald‘s, which has more than 2,000 restaurants in China, has had a long relationship with OSI and was more dependent on the supplier than Yum. Many McDonald’s China outlets have been hit by meat shortages since the company ended its relationship with OSI there.

Around two-thirds of the more than five dozen consumers Reuters reporters spoke to in Shanghai, Beijing and Hong Kong on Thursday said they would scale back their visits to McDonald‘s, at least for now. “For people like us, McDonald’s and KFC are places to meet friends,” said Yao Nanfang, a 16-year-old student in a shopping mall in central Shanghai. “We’ll still go to McDonald‘s, but we’ll order fewer meat products.” Diners in Hong Kong also said they were likely to eat less frequently at McDonald‘s, but noted that the chain’s low prices made it hard to give up. “I come to McDonald’s less often now, but I won’t completely stop coming because it’s so much cheaper than other restaurants,” said Nan Tang, who says he eats at McDonald’s twice a week. In Hong Kong, McDonald’s has ended a promotion of its chicken McSpicy burger and shifted a membership program away from offering discounts on McNuggets, which it is not currently selling. Following the TV report that alleged workers at Shanghai Husi Food used expired meat and doctored food production dates, regulators closed the plant on July 20. Police have detained five people including Shanghai Husi’s head and quality manager.

Food safety has been a big concern for Chinese consumers after dairy products tainted with the industrial chemical melamine sickened many thousands and led to the deaths of six infants in 2008.

Yum shares were down 5 percent at $69.17 in afternoon trade on the New York Stock Exchange.